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Realities of Real Estate: How market value is determined

There are many factors that go into selling real estate, but one of the most important is an honest, objective determination of what a property is really worth. Without an accurate understanding of what that number is, it’s not possible to set an effective list price, and no amount of fancy marketing will inspire someone to pay significantly more than what the market will bear. So, how do real estate agents come up with an estimate of market value?

First off, it should be clear that there is no one way. Some agents will produce volumes of market data to pinpoint a price; others rely on a few key indicators and/or some degree of gut feel. Second, the process of determining market value is not an exact science. If an agent tells you that they think your house is worth some specific number, that suggests a level of accuracy that simply doesn’t exist.  And third, it’s important to be confident that your agent is being dead honest with you and not just floating out a big number, hoping you’ll hire them, instead of the other agent who was perhaps being more realistic. All that being said, here’s how we approach the problem of figuring out what somebody might be willing to pay for a piece of property.

Start broad and narrow it down

You’ve got to start somewhere, so we initiate the process with broad strokes. Based on sheer experience, we’ll ask ourselves, “Will this house sell for something in the $600,000s, or is it more of a $500,000 kind of house? Then, we’ll narrow it down a bit more to determine if it’s a low $600,000 house, or can we push the envelope a bit and think about the mid-$600,000s.  That might all sound a little loosey-goosey, but when you’ve been in the business a long time, your initial gut feeling is often a fairly accurate starting point. Even so, there are instances when we’ll go back and correct ourselves based on market data and/or new information that we get about a property.

Look for a convergence in the data

Once we have a general idea of where we might be going with the price, our next step is to quantify our judgment by more empirical means and see if the numbers converge at a common point. To do that, we use a wide variety of resources that are all designed to estimate market value.

There are a number of Automated Valuation Models (AVMs), where computers use various algorithms to crunch the numbers and come up with an estimate. Zillow has their Zestimate, and other companies, such as Collateral Analytics, also produce sophisticated AVMs. So, we’ll take a look at what those numbers say and see if that lines up with what other properties in the neighborhood have been selling for. No two properties are exactly alike. Consequently, it is necessary to reconcile the differences. One house might have a garage, whereas another house doesn’t have a garage, but it does have a finished basement. At times, one feature can compensate for another, resulting in the two properties being of equal value.

We’ll use a number of products that produce a Competitive Market Analysis (CMA) and see if they all tend to agree on a fairly tight estimate of value. If they do, and it all corresponds with our first impressions of price, then that gives us a high degree of confidence that we’re on the right track.  Occasionally, we’ll come up with an outlier, making it necessary to check the data. In most cases, the data point that differs from the rest is coming from a source that has frequently been found to be unreliable. Zillow’s Zestimate is notoriously inaccurate, so much so that we regularly tell clients that Zestimates should be used for entertainment purposes only. Nevertheless, the degree of accuracy for Zestimates, other AVMs or any type of CMA is largely determined by the type of property you’re trying to value. For example, if you’re looking to set the value on a townhouse, where there are hundreds of other nearly identical properties, AVMs can do a pretty tight job of averaging past sales to identify value. However, if you’re looking at more unique types of real estate, like a waterfront or a big-acreage property, so many variables come into play that it isn’t possible for computer models to properly consider the relative value of each component. In that case, experience and a case-by-case comparison with similar properties that have sold becomes much more important.

Fold in market dynamics

What a property is worth at any given point in time is constantly changing. That’s because market forces are not static. The degree to which you can push toward the high end of value or be more conservative and stick with the lower end is dependent on not only where the market is today, but where you think it will be going tomorrow. Plus, the housing market doesn’t exist in isolation; it’s a function of the economy as a whole. As a result, agents who have a feel for economics can further qualify value estimates by adding in the directional impact of market forces down the road.

Beyond the economy in general, there are a myriad of other considerations that fall under the heading of market dynamics. The type of house, where it is, and the profile of buyers currently active in the market all contribute to an understanding of value. Some neighborhoods are highly sought-after, but only with certain types of property. There are times when big houses are all the rage, and times when the lay of the land is what it’s all about. The market is always changing, and it’s critically important to fully understand how the market might help or hinder the sale of a specific property.

Tighten the range

Once we get to this point, it’s usually possible to narrow down the range of value. As we said, determining market value is not an exact science, but a good real estate agent who really knows the local market can frequently get within 5 percent or less of final sales price. There can, of course, be exceptions. We’ve seen cases where just the right buyer comes along, or two buyers get into a bidding war, and that can push up the price. But hoping for that one-in-a-million buyer isn’t a good strategy for pricing real estate. You might as well buy a bunch of lottery tickets, since the odds of it all working out are about the same.

In sum, no two agents go through the same process. But whether your looking to buy or sell, make sure your agent has a reasonably reliable method for determining market value. If they seem to be winging it, or constantly asking you what you think it’s worth, then maybe it’s time to find an agent who has the expertise to help with this critically important part of making a sale.